1946 Analog Holds Key For Current Market

I love price pattern analogs, because I love just about anything that can tell me in advance what is going to happen to stock prices. If the current price behavior is similar to that of another period in history, then sometimes it can give us insights about what lies ahead.

Subscribers to our Daily Edition and our twice monthly McClellan Market Report newsletter have enjoyed getting to see this week's chart on a regular basis. It compares the ugly decline of the summer of 2011 to a very similar decline in the summer of 1946.

We first took a look at this comparison back in August 2011 because of a common factor in each period: there was no divergence in the A-D Line. Most of the time when there is a price decline as big as we have just seen, the A-D Line gives us warning of liquidity problems by making a divergent lower high as prices make a higher high. We did not get that A-D Line signal in the summer of 2011, although other divergences did tell us (and thus our subscribers) that there was trouble brewing.

1946 similarly did not have an A-D Line divergence, and so that made it worth taking a look at as a comparison model. When lining up the price patterns in a single chart, the correlation of price movements then and now became obvious.

1946 also shares other similarities with the current time frame. The U.S. was in the midst of dismantling the stimulative effects of a war-time economy, and unemployment shot up in a big way. There were also concerns about rebuilding post-war Europe, and whether or not loans would be repaid like the Lend-Lease Program. Now we have an economy with high unemployment, and the expiration of stimulative efforts like TARP and QE1 & 2. There was great labor union unrest in 1946, which led to the 1947 passage of restrictions on union activity in the Taft-Hartley Act, which passed over President Truman's veto. 2011 saw a big push back against unions in states like Wisconsin and New Jersey.

Zooming in closer, we can see that even the manner in which each of the steep declines unfolded was very similar. There was a rapid one-day drop, a slight hesitation, and then the final plunge in both cases. Rather than continuing the decline after the steep plunge, the 1946 market saw a long series of retests, with the DJIA seemingly bouncing along against a price floor for several months. The last of those came on Nov. 22, 1946, and with the price pattern alignment shown in these charts, that equates to a bottom due Oct. 21, 2011.

One point to understand about using price pattern analogs is that eventually the correlation breaks up and stops working. Often that point will arrive at the moment when one is most counting on the correlation to continue working. So one should never give these pattern analogs complete trust, no matter how good they look. But for the moment, the 1946 pattern does seem to be telling us the correct answers about how the current market's corrective period will play out.